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Accumulation units – the income tax loophole that never was

Are you an unwitting tax evader? I only ask because quite a few investors seem unaware that fund accumulation units attract income tax on dividends just as much their more transparent ‘income unit’ cousins.

Accumulation units are a class of share that automatically reinvests dividends1 straight back into your Unit Trust or OEIC fund. In contrast, income units cough up dividends directly, paying you cash like three cherries on a fruit machine.

But not physically taking delivery of your dividends is no protection from HMRC. The taxman still wants his cut. Dividends rolled up into your accumulation units are known as a ‘notional distribution’ and are taxable in exactly the same way as income units.

In other words, you owe income tax on dividend income unless:

  • You’re a basic rate taxpayer/non-taxpayer – in this case the notional tax credit attached to dividends takes care of any liability you have.
  • Your funds are held within an ISA or SIPP and are therefore off the taxman’s radar.
Accumulation units are no protection from the taxman

The taxman cometh

Higher and highest rate taxpayers are thus on the hook for income tax due on any accumulation unit dividends that are snowballing outside of tax shelters.

The dividends are reinvested net of basic rate tax, which means that higher/highest rate taxpayers will actually have to find extra cash to pay their dues, as all the divi cash is sucked up into the fund.

Worse still, some investors are no doubt paying tax twice when it comes to their capital gains tax bill!

You don’t have to pay capital gains tax on the dividends that have fattened your fund. So when you come to fathom the capital gains on your accumulation units (and as your resultant psychic scream reverberates around the universe), make sure you deduct any reinvested income from the total gain, otherwise you’ll be overpaying.

Record collection

Of course, you can only make those deductions if you’ve been meticulously recording the dividend distributions that dropped in to your accumulation funds over the years.

And who doesn’t do that…?

The problem is accumulation unit distributions are more stealthy than income unit payouts, as you don’t get to do a little dance every time those divis turn up in your trading account.

So where can you find out about them?

  • In your broker’s statement, if you’re very lucky.
  • Trustnet keeps a good account of accumulation unit distributions – find your fund then click the dividends tab.
  • In your fund’s annual report.

Worth the hassle?

The main advantage of accumulation units is to skip the cost of reinvesting dividends. But this cost saving is rendered superfluous if your fund isn’t saddled with trading fees or initial charges in the first place. Many tracker funds fall into this bracket.

Others prefer to hold income units outside of a tax shelter, as the dividend payouts can be used to rebalance, or to pay tax bills without you having to sell units and trigger capital gains woes if you breach your personal allowance.

Whichever way you go, just remember that any accumulation units in your portfolio are not immune to income tax, and start recording those dividends – just for the fun of seeing what you’re earning, if nothing else.

Take it steady,

The Accumulator

  1. Note the same is true of any income paid by an accumulation unit. But I’m sticking to the term dividends throughout this article for the sake of simplicity. []

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{ 16 comments… add one }
  • 1 Pete Comley May 16, 2012, 3:07 pm

    This is a really useful article. I have plugged that people read it in v1.1 of the Monkey with a Pin book.
    Pete

  • 2 The Accumulator May 16, 2012, 5:09 pm

    Much obliged, Pete. Have got Monkey With A Pin on my ‘to read’ list.

  • 3 LearnFrench December 13, 2012, 2:46 pm

    Thanks for explaining this. It did spur me to think of a question however. If one had money in a fund with no fees for investing or withdrawing money (as I believe is the case with the HSBC trackers) then would it be possible to avoid income tax by selling shares in the fund just before the dividend paid out and purchasing them back afterwards. Given that the share price moves to reflect the dividend amount the fact that one has not received the dividend payment should not matter.

    I am assuming here that this would all take place within one’s capital gains tax allowance and not incur any charges in this way.

  • 4 The Accumulator December 13, 2012, 6:59 pm

    Hey, LearnFrench. That sounds like a cunning ruse, but I worry that your shares could freefall after you’ve bought them back and you end up making nothing at all. Or, for whatever reason, the market spikes up before you get a chance to buy back and your short-play backfires on that count. I haven’t looked into this myself but my gut-feeling is that the real world makes it not worth the hassle. That said, I’d be very interested to hear from anyone who had tried this.

  • 5 LearnFrench January 15, 2013, 2:31 pm

    Somewhat cunning but I did think that it seemed rather too good to work myself. Does the ex-dividend fall in share price actually equal the whole dividend amount or is it perhaps a bit less to take into account income tax losses? Although given that there are different income tax rates I imagine that this could get complicated.

  • 6 Matt the Newbie March 4, 2014, 9:34 am

    I’m new to investing (to date I’ve been a cash-ISA only man) but having had a good look at this website I’m really excited by the prospect of being a little more creative with my savings.

    However! I must confess I’m still confused by the tax treatment (and since I’m a tax lawyer that’s a little embarrassing). I understand that the accumulation units (or shares in the case of OEICs) might pay out dividends and automatically reinvest them for you out of convenience. If that’s the case then surely you would have to pay tax on the dividends, you would have more shares / units in your portfolio, and your base cost would increase (so although you get taxed on the dividend, at least you don’t have to pay capital gains tax on that element further down the line).

    But is that how all OEICs work? I’m specifically looking at the Vanguard Lifestrategy range of funds at the moment. Why would they pay out a dividend, and trigger tax, and reinvest it, when the money could simply stay in the fund and be reinvested without a tax charge on the individuals, which would then increase the capital value of the shares on which you pay CGT when you finally cash out.

    Even after looking at the Key Investor Info for one of the Vguard LS range I’m confused. It uses phrases like “income from the fund will be reinvested” which to my mind is ambiguous.

    Can anyone help?

  • 7 Matt the Newbie March 4, 2014, 1:24 pm

    I think I’ve answered my own question, but for the benefit of anyone who’s interested:

    The key is that legally OEICs have a special tax regime.

    It seems that if you have an equity fund (and painting with very broad brush strokes, this is a fund which doesn’t hold at least 60% of its assets in cash / gilts / similar approved investments, and very definitely not shares) then all of its distributions are treated as dividends for tax purposes AND (crucially) any income amount which is available for distribution by the fund (i.e. income from underlying investments) is automatically treated as if it were actually distributed, whether or not cash goes out to the shareholder. So this is why the fund doesn’t actually pay out a dividend and then reinvest it. The income is allocated to reinvest in the capital of the fund (without ever leaving the fund company) but is still treated as though distributed for tax purposes.

    So that’s satisfied my curiosity. Anyone who is similarly curious can have a flick through the Authorised Investment Funds (Tax) Regulations 2006.

  • 8 Mervyn July 10, 2014, 4:00 pm

    My understanding is that with ACC units, the number of units does not change, but the base cost should increase by the dividend amount. Was wondering if this increase is the net or gross dividend. And would the effective date of that increase be on the Ex or pay date? Any answers appreciated.

  • 9 Nigel HB October 23, 2015, 9:40 pm

    Very useful article. I have been investing small monthly amounts into an accumulating tracker fund since 2002, for the purpose of creating a college fund for my darling son. These were the days before junior ISA’s and child trust funds. I have kept the statements and tax vouchers, but never really understood the importance of the vouchers. It now seems that I have been a tax evader and if I want to offset capital gains tax when selling my fund ,when my son is 18 next year, I will have to tell the tax man about the accumulated dividends over the last 13 years.

    Any thoughts on that ?

  • 10 KEM February 17, 2016, 11:18 pm

    Your article says to deduct reinvested income from gain – I understand this but am not sure how much of reinvested dividends from accumulation fund can be deducted if only part of fund has been sold – and how much of these dividends have to be deducted from gain from future sales. Any help on this would be much appreciated.

  • 11 Richard March 31, 2016, 1:22 pm

    In order to take advantage of the new £5,000 dividend nil rate band for both me and my spouse, I would like to transfer to my spouse’s trading account, as a gift, some of the holdings in my own trading account. I am thinking to transfer shares in Vanguard FTSE U.K. All Share Index A. The income version of this fund will next pay a dividend at 31 December 2016. My accumulation version has this dividend reinvested. What I want to know is: what do I need to do to be sure that the tax on the dividend is owed by my partner, rather than me. Does it make any difference whether I transfer the fund to his account early in the year, say 10 April 2016, or later in the year, say at 10 November 2016?

    I am new to investing in the UK and have not yet seen how a UK tax reporting statement from my platform will look, so I do not yet understand how this works – if one owns shares in an accumulation shares of a fund for X% of a tax year, does that mean that one owes tax on X% of the annual dividend, or is it the case that the person who owns the shares at a certain point in the year (say when the income version goes ex-dividend) owes the tax on the entire dividend for the entire year? I hope you understand the question I am asking.

  • 12 The Accumulator April 1, 2016, 5:59 pm

    @ Richard – we could take our best guess but we’re not tax experts and I think that’s what you’d need for a definitive answer. It seems reasonable to me that your partner would be liable as long as the units are in their name by the time the dividend is paid (and the divi is announced for the acc fund the same as for the inc version) but that doesn’t mean HMRC would agree.

  • 13 Rob November 30, 2016, 12:01 am

    I am looking for the answer to Richard’s question (March 31 2016) – just wondering if he ever found out? Hopefully he might get an email if he is subscribed to posts on this page. If anyone else knows, would appreciate any pointers. Thanks.

  • 14 Sarah April 6, 2017, 6:23 pm

    Does anyone have info on Mervyn’s question from 2014 as I have the same question. I have accumulation units within an ISA and get info on accumulation fund distributions, but the number of units held does not increase. Just to complicate things I am in Canada and ISAs are not tax-free here. Am I correct to believe I have to declare distributions as income (income tax payable) but when I sell units the base cost should be increased by the value of all distributions made during the life of the units, although the number of units is unchanged?

  • 15 The Accumulator April 9, 2017, 7:50 pm

    Hi Sarah, you are right that the number of units doesn’t increase, they increase in value by the amount of the dividend. Accumulation dividends do count as taxable income if not tax sheltered. But you pay that’s liable to income tax not capital gains. Therefore when calculating any CGT liability, the reinvested income should be deducted from the apparent gain to work out the true capital gain. If you don’t do that then you are taxed twice. Nasty.

  • 16 Richard April 10, 2017, 2:36 pm

    Rob asked above if I had found the answer to my own questions. Yes, here are things I have discovered.

    Firstly, so long as I transfer the fund to my spouse’s ownership before a dividend is paid, then that entire dividend will accrue to my spouse’s tax liability, even if I had been holding the fund for most of the previous accounting period. (My spouse will go forward with the same capital gains basis that I had.)

    Secondly, funds (income and accumulation) can have their dividends paid with a so-called “equalisation” amount. This happens only in your first year of ownership of the purchased shares in the fund. The equalisation amount is a return of capital. It reduces the disadvantage of buying accrued dividends. The practical effect is that for an income fund your taxable dividend in this first year is decreased by the equalisation amount, and your cost basis (for your future capital gains tax calculations when selling) is also decreased by the equalisation amount. For an accumulation fund your taxable dividend in this first year is decreased by this amount, but the cost basis is unaffected.

    Not all funds operate an equalisation regime. For example, Fundsmith Equity does not, whereas Vanguard FTSE all share does.

    ETF and company shares also do not operate any equalisation. So if you buy an ETF/share just before its ex-dividend date, you are effectively buying the next dividend, which will be returned to you in just a couple weeks. This means you will incur a small amount of dividend tax on money that has not really been invested at all long. The equalisation regime operated by funds helps eliminate this infelicity.

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